Corporate Governance Through The Banks: The Experience In Russia
Publication date
Tuesday, 30.09.1997
Authors
A. Radygin
Series
Eleventh Plenary Meeting “Banks and Privatization” Rome, September 18-19, 1997
1. Introduction
Between late 1995- 1997 the new phase of the post- privatization redistribution of property in Russia began to develop; of this phase the following major features are characteristic:
- use of non- trivial technical schemes ( loans- for- shares auctions, legalized dilution of state- owned shares, conversion of debts into securities, sales of debit liability, trust schemes, purchase of promissory notes, manipulations with preferred dividends, etc.);
- it is some largest banks ( financial groups- see Table 1), which are major subjects ( initiators ) of this new phase of the redistribution of property;
- it is the largest or the most “interesting” Russian companies, in which some structuring of control has already taken place ( including the certainty with regard to state- owned shares), which are the major objects of the afore- mentioned process;
- the government’s active assistance: while fulfilling the interests of the largest financial and industrial alliances, the government also achieves its various objectives of its own ( political, budgetary, etc.).
As to the core conflict of the above- mentioned stage, it is most likely that it may be characterized as the clash of interests between the old ( although currently in a new corporate “shell”) natural monopolies, largest industrial and mining structures, on the one hand, and the new financial and industrial groups, on the other hand: the expansionist interests of both groups have intersected in the course of the new redistribution of property. Obviously, to understand the afore-mentioned conflict, one should also take into account political factors and power interests within the different branches of the Russian power, primarily within the government.
In other words, beyond the “facade” of the largest ( including yet not completed) transactions, which took place between 1995- 1997, the final stage is happening: the essence of this stage is the redistribution of property in a number of the key Russian companies. On some of such companies the major centers of influence have already mobilized consensus, and the redistribution of property- with other conditions being equal- is most unlikely. In the other group of companies the final stage of establishment of control over the enterprise is delayed, due to the ongoing struggle and intensive lobbying; this process is multidimensional: the major participants in the process are both Federal and regional power authorities, natural monopolies, the largest banks and industrial enterprises.
It is obvious that the commercial banks currently are the most powerful financial institution, which also intensively participates in the processes of redistribution of property. Nevertheless, as it was mentioned above, only the largest banks, in which the major part of the Russian banking capital is concentrated, participate in such a struggle.
At the same time the activity of the banking sector as a whole in this sphere is also determined by the development of the general macroeconomic situation in Russia. Even between 1992- 1994 ( mass privatization) the majority of commercial banks were far from investing in industrial enterprises’ shares as in the financial instrument. If purchases of portfolios ever took place, it was done only for the purpose of control, or, more rarely, in order to resell the shares in a long-term perspective. It should be noted that the process was rather chaotic and spontaneous.
By its essence it was the first stage of the banks’ infiltration into the industrial corporate sector of the economy.[1]
The banks preferred to receive their revenues in the monetary market “ at the expense” of the expensive short- term credits and by playing on the dynamics of the RUR/ hard currency parity. Since 1993 the state securities market began to develop intensively: it attracted the banks’ resources for a long time.
It is obvious that the fall in the inflation rate and stabilization of the RUR/USD parity between 1995- 1997 ( see Fig. 1-4) became one of the key factors which caused the crisis of many small- and medium- size banks. Such banks would get used to certain “rules of the game” and instruments in the financial market and failed to adjust themselves to the new macroeconomic situation on time. Those banks which managed to re- focus themselves, in 1995- 1996 focused on the state securities, investing up to 60% of their assets in these securities.
Only since 1996 the decrease in yields of the state securities determined some transfer of financial resources to the corporate sector of the securities market. At the same time between 1996- 1997 the secondary corporate securities market showed significant reserves of growth ( capitalization). Various enterprises’ shares became of a great interest on the part of banks as a short- term financial instrument ( and not only as an instrument for establishing control).
In other words, since 1996 the second stage began of the banks’ infiltration in the industrial corporate sector, related to the search for new financial instruments. At the same time, as it was mentioned above, the largest banks ( financial groups) began a cut-throat struggle for the new redistribution of property.
2. The general state of the banking sector in 1997: terms of reference
As of early 1997, there were more than 5000 licensed ( in compliance with the requirements of RF Ministry of Finance) investment institutions. As of the same date, there were about 350 operating specialized investment privatization funds. The intensity of development of both non- government pension funds ( a. 800) and insurance market ( a. 2700 companies) is rather high; a. 130 credit unions appeared ( see Table 2). Nevertheless, it is the banking sector which is the most powerful segment of the Russian financial market.[2]
According to the data of Goskomstat of RF, as of May 1997, the number of the registered credit entities ( among which commercial banks make up 99%) amounted to 2582 units
( Table 3). At the same time, the 7 per cent reduction in the number of operating credit organizations was noted since the beginning of 1997 ( for reference: the respective rate was
7.6% for the whole 1996). The actual number of commercial banks really functioning as of May 1997 was 1887 ( given yet 39254 their affiliates, including Sberbank of RF). The total amount of authorized capital of the operating credit entities in September 1996 made up RUR 15.9 trln.
According to the data as of early May 1997, the commercial banks’ credits issued to the economy, population and banks made up RUR 270 trln., including the credits to the economy and the population- RUR 220 trln. and to banks 48 trln. Short- term credits traditionally prevail in the banks’ credit policy. The share of such credits in the total volume of credits issued to the economy and the population somewhat grew and made up over 95% ( against 92% observed in September 1996).
Among the reasons, because of which the share of long- term credits to the real sector remains very small, experts traditionally single out the following problems:
- lack of capital for the long- term crediting ( i.e. the bank has to have a significant amount of capital in order not to make probable losses critical);
- on the contrary, given free capital is in place, a lack of the experience for the work with the real sector’s projects;
- high risks of the non- return of credits and the probable situation of non- recoupment of the project on time;
- unfavorable tax climate;
- lack of strict guarantees of control over the enterprise, even if the bank has the control or the blocking stake of shares;
- the bank’s top authorities have to have stable long-term personal positions, to be interested in long- term projects.
In general terms, the banks’ infiltration into the real sector happens through the following major channels:
- short- term credits to enterprises;
- financing investment projects both in the direct ( issuance of long- term credits) and in the portfolio ( purchase of shares of new series emitted specifically for investment projects) forms;
- purchase of portfolios of shares ( in certain branches, regions, by certain characteristics of enterprises of different branches and regions, etc., depending on the concrete bank’s strategy);
- trust agreements on governing enterprises’ portfolios;
- purchase of debts of the real sector’s enterprises.
By the end of 1995, according to the data of the Central Bank of Russia, the averaged proportional weight of the banks’ investment in shares of joint- stock companies made up 7-8%, by September 1995- in enterprises’ shares- 5-6%[3], investment in state securities- over 80% of the total amount of banks’ investment in securities. At the same time the volume of the banks’ transactions with industrial enterprises’ shares was extremely unstable, well correlating to the general dynamics in the corporate securities market. On the whole the banks’ investment in non- government securities between 1994- 1995 fluctuated between 0.5- 8% of the banks’ assets. The last data as of 1997 ( Table 3) have not yet given any grounds to conclude that the banks’ investment in the corporations’ shares grew notably.
“Menatep”, ONEXIMbank, Rossiysky Credit, Nationalny Rezervny Bank”, ‘Imperial”, “Alfa- Bank”, “Incombank”, may be attributed to the most active participants in the corporate securities market. In practice the banks showing their real interest in privatized enterprises purchase those enterprises’ securities through daughter structures, that is why the real amount of capital invested by the banks to corporate securities cannot be calculated. In some cases such an investment activity is performed within the framework of a financial and industrial group, of which the bank is an informal nucleus.
In general terms, the current state of the Russian banking system is far from the ideal. After the systems crisis in summer 1995, it periodically has experienced mini- crisises. In spite of the strict control over the banks on the part of the Central Bank, by the end of 1996 more than two-thirds of the Russian commercial banks were attributed to the category of “problematic”, i.e. experiencing various difficulties. Between 1995- 1997 the Central Bank of RF canceled over 700 banking licenses because of violation of both the banking legislation and the Central Bank’s instructions. By May 1997, according to their shareholders’ decision, 360 banks were either completely liquidated or re-organized into affiliate structures. According to some estimations, in 5 years there will be not more than 200- 400 banks in this country.
3. The legal framework of banks’ investment to corporate securities ( including privatization transactions)
In the majority of the countries with the advanced security market ( US, Japan, etc.), the banks are formally prohibited or restricted in performing a number of functions of the professional participants in the security market. Such restrictions were introduced for the purpose of separation of different groups of risks ( the separation of a number of risks related to the transactions with securities from the risks directly related to banking operations themselves), in order to increase the stability of the banking system and to protect investors’ rights.
As to the Russian situation, the introduction of some restrictions in credit institutions’ activity in the securities market had been considered in early ‘90s, in the course of the elaboration of the government Resolution #78. Nevertheless, as a result, those restrictions were not introduced,- in particular, because of the fact that at that time the banks practically did not participate in transactions with securities, with the exception of placement of their own securities.
Thus, in general , in terms of normative and legislative acts the system of so called “universal banks” is taking shape in Russia , of which Germany has been the example until recent time.[4]
According to the Article 6 of the Federal Law “On banks and banking activity” of 2 December, 1990 # 395-1 ( the amendments were introduced in the new variant adopted 03 February, 1996 # 17-FZ), in compliance with the license granted by the bank of Russia for performing banking operations, the bank has a right to perform issues, purchase, sales,
depositary and custodian and other operations with those securities, which perform the function of the payment document, with the securities, which confirm the attraction of monetary capital to deposits and bank accounts, and with other securities, the performance of operations with which does not require obtaining a specific license in compliance with the Federal Law; in addition to the above, the bank has a right to enter into trust agreements with both physical and legal entities to govern the latter groups’ securities. The credit institution has a right to perform its professional activity in the securities market in compliance with the Federal Laws.
In practical terms, only a number of the normative acts concerning privatization provide restrictions with regard to banks’ purchase of Russian enterprises’ shares in the course of privatization. Thus, in compliance with p. 9.5. of the State Program of Privatization of 1993 ( which currently partially is still in force), the banks can not:
- perform as buyers of shares (stocks) of the privatized enterprises and voucher investment funds;
- possess more than 10% of stocks of any joint- stock company and cannot have more than 5% of shares of joint- stock companies within the structure of their assets;
Due to the above, the banks had to establish their daughter companies for the purpose of performing investment and trading in the corporate securities market.
The afore-mentioned qualitative restriction imposed on investing the financial and credit institutions’ resources practically correlated with the restriction concerning the banks’ activity within the framework of financial and industrial groups: not more than 10% of the banks’ resources may be invested in not more than 10% of the shares of enterprises- participants in the FIG.
It is provided in a number of the normative documents of the Central Bank of Russia that:
- reserves should be established in case the securities purchased by the bank would be devaluated;
- there are normatives with regard to the bank’s use of its own capital to purchase shares of other legal entities;
- there is the minimum amount of reserves to be accumulated under high- risk assets, as well as there are other measures with regard to the banks’ investment to securities.
4. The major types and incentives of banks’ operations with corporate securities.
The incentives for the banks’ investment in corporate securities vary greatly [5] :
- establishment of control over the concrete perspective privatized enterprise;
- purchase of shares to create certain base for the bank’s expansion to certain branches;
- purchase of shares of privatized enterprises in favor of large- scale foreign and domestic investors ( commission fee or profit resulted from the re-selling of the portfolio) ;
- redistribution in its own favor a part of revenues resulted from sales of shares owned by the government ( the system of the authorized banks);
- possession of a specific “insurance fund” ( taking into account that the government should not allow industrial giants to face bankruptcy, and it should be most likely that the government would grant some subsidies or privileges to the enterprises, which the shareholder- outsider might use too);
- possession of the largest industrial joint- stock companies’ shares to create the image of a “serious investor” ( see also FCSM, 1995- 1997).
It is obvious that the activity of commercial banks as investors in the securities market is focused mostly on the government securities market. The high profitability of the transactions with the government securities between 1993- 1996, liquidity and reliability of GKO, along with the fact that many banks have found themselves incapable of forming a qualitative credit portfolio, resulted in the extremely high proportional weight of T-bills in the structure of many commercial banks’ assets ( see p.2 and Table 3).
For a number of banks investment to enterprises’ shares is a way to establish a direct control over the enterprise. Purchasing privatized enterprises’ securities- from both large- scale strategic investors and from portfolio investors in the open market- is for many large banks a part of their strategy of forming financial and industrial groups. Such a targeted purchase of shares is the component of the processes of redistribution of property and market “correction” of the ownership structure, which initially had taken shape, resulted from the privatization of the former state- owned enterprises.
A number of large Moscow banks implement the policy of establishing their control over the perspective enterprises. The establishment of the banks’ control is accompanied with the transfer of those enterprises’ bank accounts to the respective banks. This allows the banks to get an access to cheap money and fixes the enterprises’ dependence on the banks. In a number of cases- in particular, in St. Petersburg- upon the purchase of large portfolios of shares, the banks could block already made decisions concerning a new emission of the enterprise’ s shares, in order to make the latter to claim for a bank credit.
At the same time one of the major problems related to the banks’ conscious limiting the volume of credits issued to enterprises and organizations is the incapability of the majority of the banks to analyze borrowers’ financial state, estimate risks and diversify the respective interest rate depending on such risks. As a result, many banks (with the exception of those banks being controlled by a small number of large- scale trade and/or industrial companies, which are capable of making the banks credit their projects regardless of the effectiveness of the latter) experience difficulties with placing accumulated capital. That is why, with a lack of control on the part of enterprises, banks choose easier decisions. Making investment to securities allows banks to focus on resolving the matters of investment at their head- quarters, neglecting an expensive and thorough training and education of their personnel in local affiliates, who could duly implement the program of issuance credits to enterprises.
On the whole, one cannot yet talk about the banks as a real strategic owner responsible for the enterprise’s long- term development ( in the context of the European continental model, according to which, apart from the control functions, the bank in some form also finances the enterprise). This is related both to the corporate policy of the enterprise’s managers and to a lack of the relationship: “strategic holder of shares ( of a pledge, trust,)- source of financing”- with regard to the banks.
The purchase of the privatized enterprises’ shares in favor of large- scale foreign and domestic investors, i.e. brokerage, is a very common incentive. In this sense, the banks have become a serious competitor to non- banking institutions- independent broker companies, investment companies and funds.
With their operations in the corporate securities market, the banks also often play a role of both brokers and depositories. Having the direct access to the payment system of the Bank of Russia and the possibility to use both their own and attracted capital for their operations, the banks therefore find themselves in more advantageous position, when compared with the non- banking financial institutions- and, nonetheless, the banks do not play a leading role in the corporate securities market. It happens, firstly, because of the objective reasons: due to the fact that the banks’ respective departments dealing with securities have the subordinated position; in addition to this, the operations with securities are not the priority to the banks as credit institutions. Secondly, the banks as large- scale multifunctional structures are too large to properly cope with these operations.
Thus, in particular, the broker services market with regard to corporate securities is mostly under control of Russian non- banking broker companies, while the market of depositary and custodian services is occupied by daughter companies and banks, which foreign financial institutions established in this country. That is why, according to some experts estimations, in practical terms, the strategy of development of “universal banks” in a broader sense ( those banks, which perform the complete set of classic banking operations along with operations in the securities market) has not proved to be so much efficient in this country and has a number of defects- both in terms of the market development on the whole and from the viewpoint of the Russian banks’ competitiveness in single segments of the securities market.
The purchase of shares to re-sell them then at a higher price is performed by the banks both in the course of privatization and in the secondary market. In the conditions of a high rise of market price for privatized enterprises’ shares, such operations, as a rule, turn out to be profitable. However, taking into account significant fluctuations in prices for corporate securities, if financial difficulties happen, the investment in corporate securities bear the additional danger, which often results in more severe financial trouble, which the banks may face.
For example, if the difficulties with the bank’s liquidity coincide with the period of a decrease in quotation of the securities previously bought by the bank at a higher price, the banks then, on the one hand, are confronted with the necessity to sell securities even at a lower price in order to renew the liquidity; on the other hand, the loss resulted from such transactions would immediately lead to a decrease in the banks’ own capital, thus deteriorating the economic normatives set by the Bank of Russia. Because of this, in spite of high potential profit, the banks’ portfolio investment is of a high risk to the commercial banks. At the same time the mass redistribution of the banks’ assets in favor of corporate securities may be attributed to the threat of a general systems crisis in the banking sphere.
5. Other methods of banks’ establishing control over corporations.
During the stage of privatization, between 1992- 1994, the purchase of privatized enterprises’ shares was performed by the banks via various daughter companies and mostly within the framework of the standard privatization legislature.
Between 1995-1997, the use of various “non- standard” methods initiated by the largest banks became characteristic of that period of time. This may be attributed to a whole range of reasons:
- actual failure of the “monetary” privatization of 1995- 1996 ( first of all, the lack of demand for the majority of the portfolios set for sale);
- coincidence in interests of the government ( accumulation, by any means, the revenue part of the budget) and a number of banks ( getting control in some industrial and mining corporations with minimal expenses);
- existing large debts of enterprises to the budget and to each other;
- the beginning of the new “war for property” between Russia’s biggest financial and industrial groups.
(1) Consequences of the loans- for- shares auctions ( 1995-1997).
The practice of the loans- for- shares auctions of late 1995 is well known.[6] The 12 auctions on a number of the largest Russian enterprises have brought around RUR 5.1 trln to the Federal budget, including paying off RUR 1.5 trln. of the enterprises’ debt to the government. It is two large Russian banks- “Menatep” and “ONEXIM”,- which dominated among the actual winners. Regardless of the auctions’ legal “shell”, the auctions were, in our opinion, either the “camouflaged” enterprises’ buyout, or- in the majority of cases- the direct non- competitive sale of the block of shares to the concerned banks.[7]
Upon the expiration of the pre-set term ( 1 September, 1996), the pledge holder could have a right to sell the respective block of shares in the market. Originally, the variants of a simple prolongation of the pledge agreement and various schemes of the government’s buyout of some blocks of shares were considered ( in the cases with RAO “Norilsky Nickel”, YUKOS, Surgutneftegas and Sibneft). In particular, the “ pledge pyramid” was considered, in order to arrange for a buyout of the pledged blocks of shares at the expense of new credits’; in addition to this, there were talks concerning the payment for a range of blocks of shares with the use of GKO, “ free hard currency resources of the Ministry of Finance in the commercial banks”, etc.
Finally, in late September 1996, the government and the Security Council made the joint decision, which confirmed the banks’ right to sell the pledged blocks of shares after 1 September, 1996. At the same time it was noted that such sales will be performed under the control on the part of the government and on the basis of the competitive open auctions. The blocks of shares of “Norilsky Nickel” and North- West River Steamship cannot be sold to foreign investors. As to the oil companies, the overall quota of foreign investors’ participation in such companies will not exceed 15%. It is provided that those holders of pledge who would not sell the blocks of shares within 3- 6 months, will have to secure an “efficient governing” the blocks. The government reserves the right to legally protect the owner’s interest, should an “inefficient governance” occur.
Thus, the right of choice was granted to the banks- winners. In this connection, their strategy was determined by the three conditions as follows: the concrete objective of the transaction (control or revenues), expiration of the term of the commission agreement ( 3 years) and current restrictions imposed on governing a block of shares ( while the ownership right on these shares would have eliminated these conditions). Obviously practically all the pledge holders are interested in owning the above- mentioned portfolios and at the same time in minimizing the respective financial costs.[8] In practice at that time the following variants of behavior could be possible:
(a) the least probable variant( but the simplest one)- the open competitive sale of the block of shares in the market in the conditions of a favorable market. The rise in capitalization of the majority of companies- objects of the considered scheme may assist to the return of the credit and getting profit from the sale.
(b) the variant, which is most typical for the period between 1996- 1997,- holding the right on running the enterprise, which are provided with the pledge agreement, since the willingness to maintain control is a dominating incentive for the majority of winners. Upon the expiration of the three- year term of the commission agreement, the prolongation of the latter is possible ( with the automatic prolongation of the trust), or the bank’s ( its daughter structure’s) ownership rights for the shares` can be fixed.
Some winners in the loans- for- shares auctions currently implement ( apparently, as an intermediate measure) the policy of consolidation of shares ( in their ownership) at the expense of relatively small blocks, which are put up for various tenders, and at the expense of the secondary market.
(c) transfer the right for shares to the third party with the government’s consent. This is related to the fact that within the framework of the current legislature, some holders of a pledge do not have a right to become owners of the respective enterprises’ blocks of shares. Thus, the pension fund “Surgutneftegas”, which became the pledger of 40% of shares of “its” oil holding “Surgutnftegas”, does not have a right to become an owner of a large block of shares, in compliance with the norms regulating the structure of the pension funds’ assets.
(d) sale of a part of the block in the “heated” ( by the commissioner himself) market, in order to return the credit. The rest of the block is held in trust.
(e) sale of shares ( with a slight excess over the government’s obligations under the credit) and purchase of them in ownership via affiliated entities.
The latter variant has been already used with regard to the blocks of shares of some oil holdings (“YUKOS”, “SIDANCO”), RAO “Norilsky Nickel”.
According to the results of the loan- for- shares auction in 1995, 45% of shares were assigned to Menatep and its affiliated structures as a pledge and yet 33% of shares were owned by this group according to the investment tender’s results. Upon the dilution of the YUKOS’ authorized capital ( see below about the additional issue) in 1996, the government share (i.e. the pledged block) reduced to 33.3%, the overall share of the three Menatep’s daughter companies made up 38.57%, the share of the joint- stock company “Russian Investors” ( the new shareholder, which is “close” to Menatep) was 12.79%, “YUKOS- Invest Ltd.”- 7.05%, individual investors’ share- 8.29%. Therefore, Menatep, thanks to the dilution of the government share, has kept his control over YUKOS, in one way or another controlling a. 53% of the holding’s shares.
The sale of the state-owned portfolio of shares, however, was required to obtain the qualified majority. That is why on 20 December, 1996, the commissioner- Menatep- and the Russian Fund of Federal Property put up the pledged state- owned block of the YUKOS oil company for the commercial auction with investment terms and conditions. Obviously, some joint- stock company “Monblan”- the affiliated structure of Menatep- became the “buyer” of the block. Monblan “paid” USD 160.1 mln. for the portfolio, given that the initial price was USD 160 mln. ( plus USD 200 mln. to be invested till 1998). The “competitor” of Monblan was Moscovsky Pischevoy Kombinat, which is under Menatep’s control through the financial and industrial group “Rosprom”. As a result, the Menatep’s control grew from 53 up to 89%.
The state of affairs in the transaction on the shares of “SIDANCO” oil holding is less clear. The block of 51% of the holding’s shares was put in pledge to the group “ONEXIMbank’- “MFK”. The winner in the tender, which was held on 10 January, 1997, became “Interross- Oil” affiliated company, which currently possesses 85% of the holding’s shares ( with the account of 34% of shares “additionally bought” in September 1996 and including “Chernogorneft”). The winner paid USD 129.8 mln, with the initial bid price of USD 129. The problem is that the ownership right for the daughter company- “Purneftegas”( the annual oil output of 9-12 mln. tons)- is not clear. Thus, the other oil holding- “Rosneft”- also claims for its right on the latter.[9]
The pledged block of shares (40.12%) of “Surgutneftegas” oil company, which remained under the holding’s control, was also set out for sale at the commercial tender. The block was formally purchased by some company “Surgutfondinvest”.
The perfect example of a conflict situation after the loan- for- shares auction was the struggle between “ONEXIMbank” and the former administration of RAO “Norilsky Nickel” crowned with the resignation of the latter in mid- 1996. Even today it is hard to estimate to what extent the new management is efficient, since ( with a lack of the transparent financial accounting and international audit) any estimations may become “politicized” and reflect the competing parties’ interests.
The only thing which is known is that the credits issued by the ONEXIMbank’s group made up a. RUR 370 bln. ( which is by itself the instrument of pressure), and the new administration elaborated a ” strategy of the way out of crisis”. According to a number of estimations on the part of ONEXIMbank’s competitors, the bank constrained itself with the control over the RAO’s financial flows and has not invested to production. ONEXIMbank’s representatives, in addition to other achievements of the bank, state that the bank has managed to stop the activity of many intermediaries, which would not return money to RAO for the delivered metal. At the same time, ONEXIMbank itself concentrated 99% of the RAO’s sales with the bank’s affiliated company “Interrossimpex”. All the RAO’s tax burden was laid upon Norilsky Gorno- Metallurgichesky ( Mining and Metallurgical) industrial complex, while the financial resources are concentrated in the RAO itself ( see: Latynina, 1997).
On 5 August, 1997 the commercial tender with investment conditions took place ( the object- the pledged black of 38% of shares put up at the tender by the holder of the pledge). The winner in the tender became some company “Swift”, which represented the interests of ONEXIM. The conditions of the tender were as follows: the initial bid price for the bluck - USD 147 mln., plus paying off the collateral credit- USD 170.1 mln., USD 300 mln.- investment to developing “Pelyatkinsky” gas deposit, and RUR 400 bln.- in equal shares- to finance the social sphere and to pay the RAO’s daughter companies’ debts to the Pension Fund.
The terms and conditions of the tender raised serious criticism on the part of on the part of the Audit Chamber of the State Duma of RF, General Prosecutor of RF, some ministers, etc. In particular, the major problems which caused the criticism were the following:
- the organizer of the tender is the “concerned” party ( MFK- Moscow Partners)- the member of the ONEXIMbank’s group;
- the procedures of the advance depositing the sum of USD 511 mln. were complicated;
- the short term for the submission of applications ( between 22 July- 1 August, 1997);
- the international audit has not been performed.[10]
Under such a pressure, the Prime- Minister ordered that the tender’s terms and conditions would be reviewed and the term of the tender would be suspended. Such a decision, however, contradicted the Civil Code. That is why the decision was made to examine the tender’s validity post- factum.
(2) Financial and industrial groups.
In the meantime there are various- and often contradictory- estimations of the efficiency of such structures’ activity. By mid- 1997 around 50 financial and industrial groups were officially registered in this country. Among the largest groups of “banking” origin” one should single out groups “Interrossprom” ( ONEXIMbank), “Rosprom- YUKOS”
( Menatep), “Alfa” (Alfa-bank), the group of the bank “Rossyisky Credit”. The groups are either holdings, or complex structures with a big number of daughter and affiliated companies with the cross- holdings of shares. The bank’s consolidating role ( as a subject of the corporate control) in the afore- mentioned examples is obvious- however, yet there are not any convincing data on the banks’ investment activity within the framework of a group.
At present the following difficulties in the FIGs’ functioning are noted:
- the problem of the consolidation of property under the aegis of the central company has not been yet resolved ( the FIG’s participants’ contribution to the authorized capital of the central company, as a rule, with an insignificant share of assets leads to forming “lobbying associations”, not to a concentration of financial and industrial capital);
- the banks’ minimum interest in implementation of investment projects within FIG;
- the contradiction between the overstated ( at the moment of establishment) estimation of the FIG’s potential and actual difficulties of its functioning.[11]
(3) Trust
With regard to securities, trust is attributed to those transactions which banks have a right to perform along with their major operations ( Articles 5-6 of the Law “On Banks and Banking Activity”). One of the types of the trust governance of blocks of shares became the one, which banks obtained resulted from the loans- for- shares auctions.
With the Decree of the President # 1660 of 9 December, 1996, “On the trusting of shares fixed in Federal ownership of joint- stock companies established in the process of privatization“, the banks received new opportunities. When the Decree came into force, the general provisions for transfer of state- owned blocks were determined: according to the results of a tender on the right of concluding the trust agreement on the blocks. The trust manager ( in contrast to the loan- for- shares scheme ) does not have a right to manage shares entrusted to him. Besides, in the agreement both parties stipulate restrictions in terms of trust manager’s activities on crucial matters of joint- stock company’s functioning.
As a priority, five joint- stock companies in coal industry were selected ( according, apart from other reasons, to the IMF’s requirement). That is why the more detailed government Resolution #1485 of 11 December, 1995 “ On holding tenders on the right to conclude trust agreements on managing shares fixed in federal property of joint- stock companies in coal industry ( coal companies)” from the formal viewpoint is related to coal industry only. However, it is most likely that these rules should cover other sectors of the economy as well. Nevertheless, one should not hope for an application of new standards soon. According to many experts’ estimations, the Provision on Tenders has so many defects that they should become a significant obstacle to any application of the Provision. The other negative moment is the problem of real guarantees of protection of both enterprise’s and public interests from such a temporary governing ( regardless of the provided requirements that obligations undertaken by the winner are secured with his own holdings).
Some changes to the document were introduced only in spring 1997 ( the Resolution of the RF government # 517 of 30 April, 1997, “On introduction changes to the Resolution of the government of the Russian Federation of 11 December, 1996 # 1485”. In particular, the Ministry for Fuel and Energy was authorized to perform as a founder for trust governance and to conclude with winners in tenders trust agreements on governing the shares fixed in the Federal ownership. Changes have been also introduced to the rules of holding the tenders.
(4) Privatization “wars” of 1997.
As it was between 1995- 1996, in 1997 the government regards privatization as an instrument of the resolution of the budgetary problems. The previous years’ experience showed an extremely low efficiency ( for the budget) of mass sales in the course of the ”monetary” privatization. That is why the decision was made to provide budgetary revenues at the expense of several large transactions.
It is putting 8.5% of shares of RAO “EES Rossii” up at an auction in late 1996, which may serve as another example of such a clash. The estimated preliminary cost of the transaction was about RUR 1.87 trln. It was intended that the formal buyer- Incombank’s daughter company- Swiss “Incomfinance Group AG”- would represent interests of the consortium of banks and non- banking companies headed by Nationalny Reservny Bank( “Gasprom’s “
group). According to the data we have, “CS First Boston” has failed to close the transaction ( although, according to some estimations, it had already gained 10.36% of the RAO’s shares ( while Credit Suisse controls about 20% on the whole) and at the same time played a role as the official consultant to Goskomimuschestvo on the transaction. On the other hand, according to some data, Nationalny Reservny Bank received a credit from the Central bank of Russia to “pay” for this transaction, while a part of the formal “ revenues” from the transaction were to be substituted by settlement of the RAO’s debts to Gasprom. As a result, it would not make any sense to show the transaction in the list of budgetary revenues, even if some money was formally transferred.
The largest transaction of 1997 became the sale of the blocking stake of shares (25% plus 1 share) of the financial and investment holding “Svyazinvest” at the auction held on 25 July, 1997. The holding was established in August 1995, and 51% of its shares were fixed in the Federal property, while 49% were set for sale ( 25%- for foreign and Russian investors, yet 24%- for Russian investors only). The auction was held by “MFK” bank ( the group of ONEXIMbank. The formal winner became some company MUSTCOM Ltd. from Cyprus, among the founders of which were the companies of the ONEXIM’s group ( “dominating control”), Deutsche Morgan Grenfell ( Deutschebank), Morgan Stanley broker company and Quantrum investment fund controlled by George Soros.
The winner offered USD 1.875 bln., while the competitor- TeleFUM company ( Alfa- bank, Most- bank and Telefonica de Espana) offered USD 1.710 bln. It should be noted that what the government received only slightly differs from what was offered in November 1995 by the Italian holding Stet ( USD 1.44 bln.). However, already after the failure with the initial deal, the control blocks of shares of “Rostelekom”, “Central Telegraph” joint-stock companies and some other companies were transferred to the hodling. On the whole since 1995 the capitalization of the Russian stock market grew notably.[12] Obviously, it would not be possible to receive a real price, however, it would have been possible to compensate for the government’s loss from the current undervaluation of the holding by selling the blocking stake of shares to a real strategic, not financial, investor. Then, with the sale of 24% of shares to portfolio investors, it would have been become possible to proceed on from a real price.
Although the branch requires significant amount of investment, 85% of the money received from the transaction will be forwarded to the Federal budget. It is most likely that the winner in the tender should not be regarded as a strategic investor capable of providing “Svyazinvest” with an access to the most modern telecommunication technologies. Substantially important is the fact that the holding is not a communication operator, though it may establish telephone companies. At the same time the winner in the auction also does not have a company- communication operator among its founders.
At the same time none of the largest international telecommunication companies ( or their consortium) have participated in the auction. Upon the sale of the blocking stake of shares the government does not have an instrument (apart from a complete privatization of the holding) to attract a strategic investor. Some experts also note the growing danger of the holding’s break- up: in the current situation its regional companies will have to search for strategic investors on their own. ( Starostenkova, 1997).
The serious confrontation between the largest financial groups happened in 1997 around oil companies. The beginning of the “Second Oil War” was caused by the Decree of the President #505 of 19 May, 1997, “On sale of previously fixed in the Federal ownership shares of single joint- stock companies of the fuel and energy complex of Russia” and the Resolution of the RF government, bearing the same name, # 616 of 21 May, 1997.
In compliance with these documents, the portfolios of shares of 6 oil companies- Vostsibneftegas (38%), Vostochnaya Neftyanaya Companiya( 51%), “Sibirsko- Uralskaya Neftegasochimicheskaya Kompaniya “Siberia” ( 36.28%), Tymen Oil Company “TNK “
( 48.68%), Komi TEK (21.7%) and NORCI-OIL (45.45%)- were withdrawn from the prohibition list and are to be set for sale at the specialized monetary auctions. Although those specialized auctions were designed for small private investors ( the analogue to the cheque auctions), no doubt that the competing Russian banks will be their major participants.
For 4 companies ( Vostochnaya Neftynaya Kompaniya, , TNK and NORCI- OIL) it is provided to hold investment tenders as the preliminary condition for the special auctions. The first conflict, accordingly, burst out around TNK. Thus, the major daughter company of TNK- “Nizhnevartovskneftegas” joint- stock company has struggled against the winner of the investment tender ( 40% of shares) “New Holding” company, which is the member of “Alfa-bank’s” group.
The destiny of the state- owned oil company “Rosneft” has also been defined: around 7% of its shares will be distributed among the company’s administration and employees, 51% of shares will be put up at an auction, while the rest will be sold as a single block at the commercial tender with investment conditions. According to some estimations, in the struggle for control there will be a clash of interests of such groups as “ONEXIMbank- MFK”, “Menatep”, “Inkombank”, Lukoil, Gasprom, the “Sibneft- LogoVaz- Obyedinenny Bank” grouping, and foreign partners of Rosneft.
(5) Restructuring enterprises’ debts.
It is most likely that the new phase of the redistribution of property ( both between the state and other subjects “concerned” and between the largest financial and industrial alliances) will be also connected with debt relations and their transformation into property rights. This, in particular, serves as an additional proof to the fact that the key participants in the process of the redistribution are the largest creditors- the government, financial groups and natural monopolies, which have both common and opposite interests.
In this connection, it is necessary to note three interesting documents related to the emission of shares and obligations by privatized enterprises:
(a) the Decree of the President # 1504 of 20 July, 1996 “On measures on liquidation of backwages and arrears of joint- stock companies”. Decree allows to those enterprises, the
state- owned block in which exceeds 25%. of shares, to hold new isues in order to pay off their debts to the budget. In other words, there is an alternative: either the government share would grow at the expense of a new issues ( i.e. the shares are recognized as the offset against the debt), or the dilution of the government stocks in favor of other shareholders ( “strategic”, according to the first scheme, and/or small- size “financial shareholders in case of a public placement) happens.
The first sample of such type became the placement of the issue of YUKOS oil company. The issue amounts to RUR 499 bln. and was placed among the shareholders and by the open subscription ( but among “ friendly” structures). By the moment of the issue, the Menatep’s structures owned 33% of the company’s shares ( by the results of the investment tender), and they were the holder of a pledge of yet 45% of shares. The YUKOS’ authorized capital grew by more than 30% ( by RUR. 2.3 bln.) and made up RUR 8.9 bln. The state- owned block in the company decreased from 45 to 33.3%.
(b) The Decree of the President # 1203 of 17 August, 1996 “On issue of bonds by organizations for the purpose of restructuring their arrears with regard to compulsory payments to the Federal budget”. It is envisioned that this would help many enterprises to avoid sales of their holdings against debts ( liquidation). In other words, in a number of cases the bankruptcy is merely postponed and the government receives the enterprise’s obligations. The enterprise’s holdings or the third party’s guarantees are pledged on the security of obligations. The government has a right to either sell those bonds before the maturity date or to receive from the enterprise the respective sum plus certain percentage at the maturity date.
(c) Resolution of the RF government # 254 of 5 March, 1997 “ On the conditions and order of restructuring organizations’ debts on payments to the federal budget “. The last document ( which appeared nearly on the eve of the well- known cabinet reshuffle) is crucially important. Those companies, which have arrears to the Federal budget as of 1 January, 1997 (major debt) as well as penalties and fines on this debt, perform debt restructuring through issuance of securities ( shares or bonds) as collateral for major debt. Should shares be issued, the control block will be submitted to the Russian Fund of Federal Property as collateral. The issuer should pay off the major debt (by equal monthly payments over the period of five years) and penalties and fines ( over the ten year period, on a lumpsum basis), otherwise the shares are subject to sales. The analogous scheme- sales of assets pledged on the security of the given bonds- is also provided, should the bonds be issued ( keeping in mind the specifics of such securities). As in many other known documents ( concerning the loans- for- shares auctions and trust), this document has several defects from the viewpoint of the current legislature.
The present Resolution- if to assume that the largest banks are interested in an implementation of it most of all- may be regarded as some alternative to the intensifying activity on the part of, for example, Gasprom, on the sale of debit liability ( or, on the contrary, to maintain such a liabilitiy, in order to convert them into the ownership rights afterwards).[13]
In the majority of the afore- mentioned cases, the problem undoubtedly is not the applied technique. It is known that in the growth period of the 1880s in Russia, such forms of resource acquirement from the capital market were practiced among industrial enterprises, as emission of obligations and collateral of shares in commercial banks*. The key problem of the current phase of redistribution of property remains the same - a discrepancy between the institutional and legal base, as well as mechanisms of “cut-off” and control over the interest of both narrow groups ( private and/or public ones) or populist and securing of their “filtration”.
It may be implemented in practice only through special Federal Laws which should exclude any legislative preferences and “special relationships” with the government. It should also secure rigid public competition and give details on access, control, and liability. Political will should also be an obvious condition in order to both maintain the given mechanism and protect it from a criminal component.
6. Conclusion: the banks and the forming model of corporate governance
Despite the fact that by the formal legal signs the model of universal bank is taking shape in this country, it is not yet possible to talk about banks as a real strategic owner responsible for the enterprise’s long- term development ( in the context of the European model, in which, apart from control, the bank also performs, in one form or another, financing of the enterprise.)
On the one hand, there are a whole number of characteristic features of the Russian economy, thanks to which it is clearly inclined to the banking- focused ( continental) type of the financial system. First of all, the economy’s industrial sector, which has found itself in the situation of the severe crisis, is incapable of providing a necessary level of investment to modernization and restructuring of production at the expense of self- financing. In addition to the lack of capital, it is inflational expectations and inefficient management, which are the factors of suppression of investment activity. As to inefficient management, it is determined by both a lack of market control ( competition) and defects in the “intrareform” management related to the non- completion of the property transformation and therefore to the uncertainty in major manager’s incentives.
The market of liquid securities, which takes shape rather slowly in terms of turnover of the industrial corporations’ shares also determines the problem of a lack of outside mechanisms of the capital market’s control over the Russian corporations’ activity. It is also obvious that there is the trend to banks’ establishing control over enterprises through creation of holdings and financial and industrial groups.
On the other hand, the afore- mentioned reasons in favor of the forming of the banking- focused model in Russia- with all their indisputability- cannot be an absolute statement, due to many current opposite trends. These opposite trends either neutralize the banks’ role in the forming Russian financial system or testify in favor of the market- oriented ( Anglo- American model).
Firstly, within the framework of mass privatization, the dispersion of the Russian enterprises’ joint- stock capital was made ( the current non- liquidity of the majority of shares and the trend to concentration in this case are secondary to this general process).
Secondly, the concentration of ownership rights, which started yet in the course of privatization, does not mean at all that there would be a dominating transfer of those rights to the banks, since at present the types of institutional investors in the structure of Russian enterprises’ joint- stock capital may vary greatly.
Thirdly, the typical structure of joint- stock capital, which has taken shape in the process and immediately after the completion of mass privatization, has rather an amorphous structure. The process of erosion of shares received by employees continues too. In other words, the struggle for the control block, which is characteristic of the present time, is going on between managers, banks, investment institutions, and the banks play a serious, but not the exclusive, role in this struggle.
In the fourth place, certain exaggerated impression on Russia’s aspiration to the banking- focused model of the financial system may be caused by first of all the largest Moscow banks’ ( financial groups’) activity, which, however, does not mean that this situation is typical for Russia on the whole.
Fifthly, the enterprises, regardless of certain reduction in their share in the banks’ joint- stock capital, often keep their status of founders of banks. According to the data of some surveys, enterprises own on average up to 50% of shares in the former special banks’ capital and up to 20%- in the new commercial banks’ capital. The above- mentioned condition constrains ( to the extent to which the founders may have a pressure upon the banks) the pro- market modification of the banks’ credit policy. At the same time many banks by their essence are just corporate treasury departments for large- scale enterprises.
In the sixth place, the control on the part of some largest banks is weakened by their specific role of intermediaries between the government and enterprises. In hope for the state support to some enterprises the banks practically does not control the latter’s activity.
In the seventh place, it is also necessary to take into account the hard financial situation of banks themselves. Due to this fact, many banks cannot bear additional costs related to control over enterprises. It is provincial small- and medium-size banks, which find themselves in the most difficult position ( such banks were established on the basis of former special banks’ affiliates and departments). It is these banks, the assets of which are at most “tied up” to issuance of credits to enterprises. At the same time, as to many relatively large banks with more stable financial position and qualified personnel, the credits to production often make up only an insignificant part of the assets. At present only a small group of Russian banks deal with the issuance of commercial credits to Russian industrial enterprises. The refuse to issue a credit, of course, also is a specific form of control over the enterprise, at least it may become an outsider’s appraisal of the management’s quality. However, it is obvious that it is insufficient as a prevailing form.
Finally, when compared with industrial sector, the Russian banking sector is not of a large size and does not have a big experience.
Thus, according to a number of experts’ estimations, it is rather improbable that within the forthcoming few years the banking sector in organizational terms could be able to meet the growing needs in financing enterprises. This therefore allows to very cautiously talk about the forming banking- focused model of the financial system in this country, since this matter is still open.
Bibliography
Gorbatova L. (1994): Financial and industrial interlinks in the russian economy. Moscow: VSE.
FCSM (1995): "Problems of the Development of the Securities Market in Russia". Report of the Federal Commission on Securities and the Stock Exchange of the Russian Government. M., July 1995.
FCSM (1996): “Problems of the Development of the Collective Investors in Russia". Report of the Federal Commission on Securities Markets. M., August 1996.
FCSM (1997): "Development of the Securities Market in Russia". Report of the Federal Commission on Securities Market. M., June 1997.
GKI RF (1997): “Results of privatization in 1996". State Committee of the RF on the Management of State Property.
Goskomstat RF (1996): “Social and economic situation in Russia. January-September 1996”. Moscow, N 9.